December 24, 2012

Change the tax environment by raising rates or adversely modifying the rules, and taxpayers, especially those in the upper echelons of earners, can be counted on to modify their conduct accordingly; there’s no reason to think their wish to hold on to their money has diminished just because the tax code has changed.

Economists as far back at J. B. Say and Gustave de Molinari in the 19th century understood this. As Molinari wrote in his 1899 book, The Society of To-morrow, “The laws of fiscal equilibrium set a strict limit to the degree within which it is possible to impose new taxes, or to increase the rates of those already in force. The relative productivity of taxes soon shows when this point has been overstepped, for then returns not only cease to rise, but immediately begin to fall.”

Things can work in the other direction too. Other things being equal, cutting tax rates can prompt revenues to rise. This is not to say rising revenue is a good thing. As Milton Friedman once said, if a tax-rate cut brings in more revenue, the rates weren’t cut enough. Hear, hear! . . .

Leaving recessions out of the account, for the past 60 years federal tax revenues have been rather steady at just under 19 percent GDP regardless of the tax rates. The top income-tax rate has ranged from a low of 28 percent in 1988-90 to a high of 92 percent in 1952-53, yet the flow of money has been a fairly constant proportion of the economy. This would seem to confirm the apparently controversial hypothesis that taxpayers are purposive human beings who can be counted to modify their behavior according to the incentives and disincentives that government places in their paths.

Yet most politicians don’t get it.

Two things. First, most politicians aren’t good at math. That’s one reason they went into politics in the first place. Second, it’s not so much about revenue as it is about control. Particularly in Obama’s case, it’s about punishing high-earners — or as he puts it, “fairness.”

Also, while revenue may be roughly the same at different tax rates, higher tax rates produce more distortions in the economy, and inflict deadweight losses from conduct that is driven by taxes rather than economics. That’s why research shows that GDP grows faster when tax rates are lower. But if you derive your own sense of importance from slicing up the pie, you don’t care as much whether the pie grows or not.

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